Discussion Question:
1. Briefly discuss how to identify good investments. What are some of the criteria you would use to make this decision? (250-400 words) with citation.
Solve various time value of money scenarios
1. Jeff just hit the jackpot in Las Vegas and won $25,000! If he invests it now at a 12% interest rate, how much will it be worth in 20 years?
2. Evan would like to have $2,000,000 saved by the time he retires in 40 years. How much does he need to invest now at a 10% interest rate to fund his retirement goal?
3. Assume that Stephanie accumulates savings of $1 million by the time she retires. If she invests this savings at 8%, how much money will she be able to withdraw at the end of each year for 20 years?
4. Katelyn plans to invest $2,000 at the end of each year for the next seven years. Assuming a 14% interest rate, what will her investment be worth seven years from now?
5. Assuming a 6% interest rate, how much would Danielle have to invest now to be able to withdraw $10,000 at the end of each year for the next nine years?
6. Jim is considering a capital investment that costs $485,000 and will provide the following net cash inflows:
|
Year
|
Net Cash Inflow
|
|
1 .....................................................................
2......................................................................
3 .....................................................................
|
S300,000
200,000
100,000
|
Using a hurdle rate of 12%, find the NPV of the investment.
7. What is the IRR of the capital investment described in question 6.
Comparing capital budgeting methods
The following table contains information about four projects in which Hughes Corporation has the opportunity to invest. This information is based on estimates that different managers have prepared about their potential project.
|
Project
|
Investment
Required
|
Net Present
Value
|
Life of
Project
|
Internal Rate
of Return
|
Profitability
Index
|
Payback Period
in Years
|
Accounting Rate
of Return
|
|
A ....
|
$ 200,000
|
$ 52,350
|
5
|
22%
|
1.26
|
2.86
|
18%
|
|
B
|
. $ 400,000
|
$ 72,230
|
6
|
25%
|
1.18
|
2.96
|
15%
|
|
C
|
.. $1,000,000
|
$224,075
|
3
|
20%
|
1.22
|
2.11
|
11%
|
|
D
|
.. $1,500,000
|
$ 85,000
|
4
|
13%
|
1.06
|
3.00
|
22%
|
Requirements
1. Rank the four projects in order of preference by using the
a. net present value.
b. project profitability index.
c. internal rate of return.
d. payback period.
e. accounting rate of return.
2. Which methods do you think is best for evaluating capital investment projects in general? Why?
Compute payback period unequal cash inflows
Sikes Hardware is adding a new product line that will require an investment of $1,500,000. Managers estimate that this investment will have a 10-year life and gene ate net cash inflows of $315,000 the first year, $285,000 the second year, and $240,000 each year thereafter for eight years. The investment has no residual value.
Compute the payback period.
Evaluate an investment using all four methods
River Wild is considering purchasing a water park in Oakland, California for $2,000,000. The new facility will generate annual net cash inflows of $510,000 for nine years. Engineers estimate that the facility will remain useful for nine years and have no residual value. The company uses straight-line depreciation. Its owners want payback in less than five years and an ARR of 12% or more. Management uses a 10% hurdle rate on invest-ments of this nature.
Requirements
1. Compute the payback period, the ARR, the NPV, and the approximate IRR of this investment.
2. Recommend whether the company should invest in this project.